Hostname: page-component-7c8c6479df-ph5wq Total loading time: 0 Render date: 2024-03-27T17:05:03.829Z Has data issue: false hasContentIssue false

Dynamic Style Preferences of Individual Investors and Stock Returns

Published online by Cambridge University Press:  01 June 2009

Alok Kumar*
Affiliation:
McCombs School of Business, University of Texas at Austin, 1 University Station, B6600, Austin, TX 78712. akumar@mail.utexas.edu

Abstract

This study shows that individual investors systematically shift their preferences across extreme style portfolios (small vs. large, value vs. growth). These preference shifts are influenced by past style returns and earnings differentials, and advice from investment newsletters, but are unaffected by innovations in macroeconomic variables or shifts in expectations about future cash flows. Furthermore, investors’ dynamic style preferences influence returns along multiple dimensions: i) the contemporaneous relation between style returns and style-level preference shifts is strong, ii) there is weak evidence of style return predictability, and iii) the correlations among stocks within a style increase when investors move into or out of the style with greater intensity. Overall, the results indicate that stock categorization influences investors’ portfolio decisions and stock returns.

Type
Research Articles
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2009

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

Baker, M., and Wurgler, J.. “Investor Sentiment and the Cross-Section of Stock Returns.” Journal of Finance, 61 (2006), 16451680.Google Scholar
Bakshi, G. S., and Chen, Z.. “Baby Boom, Population Aging, and Capital Markets.” Journal of Business, 67 (1994), 165202.Google Scholar
Barber, B. M., and Odean, T.. “Trading Is Hazardous to Your Wealth: The Common Stock Investment Performance of Individual Investors.” Journal of Finance, 55 (2000), 773806.Google Scholar
Barber, B. M.; Odean, T.; and Zhu, N.. “Do Retail Trades Move Markets?Review of Financial Studies, 22 (2009a), 151186.Google Scholar
Barber, B. M.; Odean, T.; and Zhu, N.. “Systematic Noise.” Journal of Financial Markets, forthcoming (2009b).Google Scholar
Barberis, N., and Shleifer, A.. “Style Investing.” Journal of Financial Economics, 68 (2003), 161199.Google Scholar
Barberis, N.; Shleifer, A.; and Wurgler, J.. “Comovement.” Journal of Financial Economics, 75 (2005), 283317.Google Scholar
Bennett, J. A.; Sias, R. W.; and Starks, L. T.. “Greener Pastures and the Impact of Dynamic Institutional Preferences.” Review of Financial Studies, 16 (2003), 12031238.Google Scholar
Bernard, V. L., and Thomas, J. K.. “Evidence that Stock Prices Do not Fully Reflect the Implications of Current Earnings for Future Earnings.” Journal of Accounting and Economics, 13 (1990), 305340.Google Scholar
Bernstein, R.Style Investing. New York, NY: John Wiley and Sons, Inc. (1995).Google Scholar
Boyer, B. “Style Investing and Comovement among Stocks with Similar Book-to-Market Ratios.” Working Paper, Brigham Young University (2006).Google Scholar
Boyer, B., and Zheng, L.. “Who Moves the Market? A Study of Stock Prices and Investment Cashflows.” Working Paper, University of California at Irvine (2004).Google Scholar
Brown, G. W., and Cliff, M. T.. “Investor Sentiment and the Near-Term Stock Market.” Journal of Empirical Finance, 11 (2004), 127.Google Scholar
Brown, S. J., and Goetzmann, W. N.. “Mutual Fund Styles.” Journal of Financial Economics, 43 (1997), 373399.Google Scholar
Campbell, J. Y.; Lo, A.; and MacKinlay, A. C.. The Econometrics of Financial Markets. Princeton, NJ: Princeton University Press (1997).Google Scholar
Carhart, M. M. “On Persistence in Mutual Fund Performance.” Journal of Finance, 52 (1997), 5782.Google Scholar
Chan, L. K.; Chen, H. L.; and Lakonishok, J.. “On Mutual Fund Investment Styles.” Review of Financial Studies, 15 (2002), 14071437.Google Scholar
Chan, L. K.; Jegadeesh, N.; and Lakonishok, J.. “Momentum Strategies.” Journal of Finance, 51 (1996), 16811713.Google Scholar
Chordia, T.; Roll, R.; and Subrahmanyam, A.. “Order Imbalance, Liquidity, and Market Returns.” Journal of Financial Economics, 65 (2002), 111130.Google Scholar
Cooper, M. J.; Gulen, H.; and Rau, P. R.. “Changing Names with Style: Mutual Fund Name Changes and Their Effects on Fund Flows.” Journal of Finance, 60 (2005), 28252858.Google Scholar
Cutler, D. M.; Poterba, J. M.; and Summers, L. H.. “What Moves Stock Prices?Journal of Portfolio Management, 15 (1989), 412.Google Scholar
Elton, E. J., and Gruber, M. J.. “Homogeneous Groups and the Testing of Economic Hypotheses.” Journal of Financial and Quantitative Analysis, 4 (1970), 581602.Google Scholar
Elton, E. J., and Gruber, M. J.. “Improved Forecasting through the Design of Homogeneous Groups.” Journal of Business, 44 (1971), 432450.Google Scholar
Fama, E. F., and French, K. R.. “The Cross-Section of Expected Stock Returns.” Journal of Finance, 47 (1992), 427465.Google Scholar
Fama, E. F., and French, K. R.. “Industry Costs of Equity.” Journal of Financial Economics, 43 (1997), 153193.Google Scholar
Ferson, W. E., and Schadt, R. W.. “Measuring Fund Strategy and Performance in Changing Economic Conditions.” Journal of Finance, 51 (1996), 425461.Google Scholar
Fisher, K. L., and Statman, M.. “Investor Sentiment and Stock Returns.” Financial Analysts Journal, 56 (2000), 1623.Google Scholar
Forbes, K. J., and Rigobon, R.. “No Contagion, Only Interdependence: Measuring Stock Market Comovements.” Journal of Finance, 57 (2002), 22232261.Google Scholar
Foster, G.; Olsen, C.; and Shevlin, T.. “Earnings Releases, Anomalies, and the Behavior of Security Returns.” The Accounting Review, 59 (1984), 574603.Google Scholar
Frazzini, A., and Lamont, O. A.. “Dumb Money: Mutual Fund Flows and the Cross-Section of Stock Returns.” Journal of Financial Economics, 88 (2008), 299322.Google Scholar
French, K. R., and Roll, R.. “Stock Return Variances: The Arrival of Information and the Reaction of Traders.” Journal of Financial Economics, 17 (1986), 526.Google Scholar
Froot, K. A.; O’Connell, P. G. J.; and Seasholes, M. S.. “The Portfolio Flows of International Investors.” Journal of Financial Economics, 59 (2001), 151193.Google Scholar
Froot, K. A., and Teo, M.. “Style Investing and Institutional Investors.” Journal of Financial and Quantitative Analysis, 43 (2008), 883906.Google Scholar
Fung, W., and Hsieh, D. A.. “Empirical Characteristics of Dynamic Trading Strategies: The Case of Hedge Funds.” Review of Financial Studies, 10 (1997), 275302.Google Scholar
Gemmill, G., and Thomas, D. C.. “Noise Trading, Costly Arbitrage, and Asset Prices: Evidence from Closed-End Funds.” Journal of Finance, 57 (2002), 25712594.Google Scholar
Goetzmann, W. N., and Massa, M.. “Index Funds and Stock Market Growth.” Journal of Business, 76 (2003), 128.Google Scholar
Gompers, P. A., and Metrick, A.. “Institutional Investors and Equity Prices.” Quarterly Journal of Economics, 116 (2001), 229259.Google Scholar
Goyal, A. “Demographics, Stock Market Flows and Stock Returns.” Journal of Financial and Quantitative Analysis, 39 (2004), 115142.Google Scholar
Graham, J. R., and Harvey, C. R.. “Market Timing Ability and Volatility Implied in Investment Newsletters’ Asset Allocation Recommendations.” Journal of Financial Economics, 42 (1996), 397421.Google Scholar
Graham, J. R., and Kumar, A.. “Do Dividend Clienteles Exist? Evidence on Dividend Preferences of Retail Investors.” Journal of Finance, 61 (2006), 13051336.Google Scholar
Holland, J. H.; Holyoak, K. J.; Nisbett, R. E.; and Thagard, P. R.. Induction: Processes of Inference, Learning, and Discovery. Cambridge, MA: MIT Press (1986).Google Scholar
Hvidkjaer, S. “Small Trades and the Cross-Section of Stock Returns.” Review of Financial Studies, 21 (2008), 11231151.Google Scholar
Ivković, Z., Poterba, J., and Weisbenner, S..“Tax-Motivated Trading by Individual Investors.” American Economic Review, 95 (2005), 16051630.Google Scholar
Ivković, Z.; Sialm, C.; and Weisbenner, S.. “Portfolio Concentration and the Performance of Individual Investors.” Journal of Financial and Quantitative Analysis, 43 (2008), 613655.Google Scholar
Jegadeesh, N., and Titman, S.. “Returns to Buying Winners and Selling Losers: Implications for Market Efficiency.” Journal of Finance, 48 (1993), 6591.Google Scholar
Kraus, A., and Stoll, H. R.. “Price Impacts of Block Trading on the New York Stock Exchange.” Journal of Finance, 27 (1972), 569588.Google Scholar
Kumar, A., and Lee, C. M. C.. “Retail Investor Sentiment and Return Comovements.” Journal of Finance, 61 (2006), 24512486.Google Scholar
Lakonishok, J.; Shleifer, A.; and Vishny, R.. “The Impact of Institutional Trading on Stock Prices.” Journal of Financial Economics, 32 (1992), 2343.Google Scholar
Lee, C. M. C.; Shleifer, A.; and Thaler, R. H.. “Investor Sentiment and the Closed-End Fund Puzzle.” Journal of Finance, 46 (1991), 75109.Google Scholar
Malkiel, B. G. A Random Walk Down Wall Street. New York, NY: W. W. Norton and Company (1996).Google Scholar
Metrick, A. “Performance Evaluation with Transactions Data: The Stock Selection of Investment Newsletters.” Journal of Finance, 54 (1999), 17431775.Google Scholar
Mullainathan, S. “Thinking through Categories.” Working Paper, Harvard University (2002).Google Scholar
Neal, R., and Wheatley, S. M.. “Do Measures of Investor Sentiment Predict Returns?Journal of Financial and Quantitative Analysis, 33 (1998), 523547.Google Scholar
Newey, W. K., and West, K. D.. “A Simple, Positive Semi-Definite, Heteroskedasticity and Autocorrelation Consistent Covariance Matrix.” Econometrica, 55 (1987), 703708.Google Scholar
Poterba, J. M. “Demographic Structure and Asset Returns.” Review of Economics and Statistics, 83 (2001), 565584.Google Scholar
Roll, R. “Orange Juice and Weather.” American Economic Review, 74 (1984), 861880.Google Scholar
Roll, R. “R 2.” Journal of Finance, 43 (1988), 541566.Google Scholar
Shiller, R. J. “Do Stock Prices Move Too Much to Be Justified by Subsequent Changes in Dividends?American Economic Review, 71 (1981), 421436.Google Scholar
Shiller, R. J. “Stock Prices and Social Dynamics.” Brookings Papers on Economic Activity, 2 (1984), 457510.Google Scholar
Shiller, R. J. “Fashions, Fads, and Bubbles in Financial Markets.” Market Volatility. Cambridge, MA: MIT Press (1989), 4968.Google Scholar
Shleifer, A. “Do Demand Curves for Stocks Slope Down?Journal of Finance, 41 (1986), 579590.Google Scholar
Shleifer, A. Inefficient Markets: An Introduction to Behavioral Finance. Cambridge, UK: Oxford University Press (2000).Google Scholar
Shleifer, A., and Vishny, R. W.. “The Limits of Arbitrage.” Journal of Finance, 52 (1997), 3555.Google Scholar
Sias, R. W., and Starks, L. T.. “Return Autocorrelations and Institutional Investors.” Journal of Financial Economics, 46 (1997), 103131.Google Scholar
Sias, R. W.; Starks, L. T.; and Titman, S.. “Changes in Institutional Ownership and Stock Returns: Assessment and Methodology.” Journal of Business, 79 (2006), 28692910.Google Scholar
Summers, L. H. “Does the Stock Market Rationally Reflect Fundamental Values?Journal of Finance, 41 (1986), 591601.Google Scholar
Tanous, P. J. Investment Gurus. Paramus, NJ: New York Institute of Finance (1997).Google Scholar
Teo, M., and Woo, S. J.. “Style Effects in the Cross-Section of Stock Returns.” Journal of Financial Economics, 74 (2004), 367398.Google Scholar
Warther, V. A. “Aggregate Mutual Fund Flows and Security Returns.” Journal of Financial Economics, 39 (1995), 209235.Google Scholar
Wermers, R. “Mutual Fund Herding and the Impact on Stock Prices.” Journal of Finance, 54 (1999), 581622.Google Scholar
Wurgler, J., and Zhuravskaya, E.. “Does Arbitrage Flatten Demand Curves for Stocks?Journal of Business, 75 (2002), 583608.Google Scholar